Microsoft Executive Martin Tobias: Leveraging the Eco-Advantage

In his book Green to Gold, co-author Andrew Winston argues that “behind the Green Wave lie two interlocking sources of pressure: First, the limits of the natural world could constrain business operations, re-align markets and perhaps even threaten the planet’s well-being. Second, companies face a growing spectrum of stakeholders who are concerned about the environment.” While the second point is self-evident, the first is debatable. The limits of the natural world have always been a constraint throughout recorded history, driving civilization to find ways around such obstacles. A new wave of young business leaders personified by TerraCycle’s Tom Szaky and Imperium Renewables’ Martin Tobias- whose stories follow-are part of a long line of entrepreneurs who see opportunity in the interface of business and the environment in ways that meet real demands. (You can’t save the world on an empty bank balance.) If there really is gold in going green, it lies not in “doing the right thing,” whatever that may mean, but by satisfying genuine unmet needs using coherent business models.

Energy That’ s Plug-Compatible

Entrepreneur and former Microsoft executive Martin Tobias thinks there is a huge business in making diesel from vegetable waste.

As a young technologist for Microsoft who helped set up its volume licensing program, Martin Tobias was intoxicated with the idea of building what would become a major business under the noses of giants such as IBM. Today, the Seattle-born venture capitalist and “serial entrepreneur” thinks he can do this again under the noses of ADM, Cargill, Chevron and ExxonMobil.

An OregonState graduate and selfdescribed tech geek, Tobias began his career as a management consultant at Andersen Consulting, then spent the next six years with Microsoft. In 1997, he founded Loudeye Technologies, which, under his guidance, became one of the largest providers of audio and video encoding for the Internet.

After leaving Loudeye, Tobias invested in and later joined Seattle Biodiesel, which was working to commercialize a new design for biodiesel refining. From this, Imperium Renewables was formed in 2005 with Tobias as its CEO. The Seattle company operates one of the largest biodiesel refineries in the U.S., producing 100 million gallons a year in Grays Harbor, Wash.

A corporate chief who likes motorcycles (he and his wife Alex were featured in the 1998 film Biker Dreams, a documentary about people who ride their motorcycles around America), Tobias is a venture capitalist first and environmentalist second. He is convinced the economics of renewable energy sources favor diesel from agricultural sources (mostly soybeans) rather than ethanol, which has a host of technical problems. (Ethanol can’t be transported through pipelines; biodiesel can.) Moreover, demand for diesel from renewable sources is steep outside of the U.S.; Europe, for example, will burn more diesel than unleaded gasoline this year. It also has more aggressive mandates to use renewables than does the U.S.

With another $500 million in capital to more than triple present capacity, Tobias is betting that his business model will enable the maverick firm to become the dominant player in this market by 2008.CE recently talked about energy alternatives with Tobias in New York City.

You have a technology pedigree- why get involved in energy?

Every few years, I focused on a different area of technology-security software, operating systems, health care. I always looked for an inefficient market-a vertical industry that had less IT than it needed or not enough start-ups or venture capitalists. The trouble is that most technology industries today are more or less efficient in this respect.

For example, in 2000 I started an anti-spam company and spent a year looking at every possible technology related to anti-spam and market trends related to email threats. I found the management team that I liked and I invested in them. Within three months, there were five other wellfunded start-ups with good managing teams all going after the same small technology market.

Rather than go down the same technology path, I looked around for a problem where I felt my DNA could make a difference. In 10 years prior to 2004, less than 1 percent of all venture capital had been spent on energy investments. When you compare the percentage that we have spent on doing things like finding the next enterprise software telecom infrastructure, you realize that as a country-let alone the VC community-we have underinvested in energy. Everyone assumes Big Energy will take care of it or are the only ones with the vast amounts of capital needed to invest. But that isn’t true. There’s inefficiency when it comes to renewables, and it’s a field where I felt I could leverage my experience in technology to move things forward.

Why biodiesel and why now?

There are a number of different energy fields that could solve our energy problem-solar, fuel cells, wind and others. A lot of these are still in the R&D phase where another 15 to 20 years of basic material science research is needed before they become commercially ready. I wanted to make a difference in my lifetime-which I define as two to three years, because if I can’t do something in that timeframe it’s not going to happen. In technology, if you can’t have the idea, hire a bunch of programmers, and get it to market in two years, you might as well forget about it

Biodiesel is an industry that is at this stage. The basic chemistry of making biodiesel is chemistry 101. You take vegetable oil, put methanol in with a base catalyst, stir with a spoon, and you get biodiesel. Unlike hydrogen and fuel cells, no additional fundamental chemistry or physics are needed. And the problem with the solar industry is that solar panels are only 30 percent efficient. A fundamental material science advance on the efficiency of silicon converting sunlight to energy is required to get efficiency up to 40 or 50 percent, which means reaching profitability requires hard-core R&D.

Since biodiesel is easy to make, all you need is a way to transform it from a mom-and-pop industry. The challenge lies in the commercialization, making on a large scale something that has always been done on a small scale.

Is that what you’re doing?

Yes. Under construction in Grays Harbor, Washington, is a refinery-the largest of its type in the country-that will produce 100 million gallons. Presently, we have a five million gallon a year refinery that has been running since May of 2005. This refinery has a separate P&L and is profitable. The company is not presently profitable because we are investing in the new refinery, but the new refinery will generate about $320 million of topline revenue and about $60 million of EBITDA. It’s already 50 percent pre-sold, meaning I have contracts with customers.

Who are your customers?

Large industrial users of the diesel. Diesel is a 62 billion gallon a year market in the U.S., growing at about 2 percent a year. And the only difference between my diesel and that of the major producers is that theirs comes from petroleum and mine is made from vegetable oil with less carcinogens and less carbon. The beauty of biodiesel is that its chemical and its Btu value is exactly the same as the product it replaces.

What about ethanol?

Ethanol is about 33 percent less Btu per gallon unleaded, and you can use only about 10 percent of it in existing engines before you have to change your engine to one of these flex fuel vehicles to be able to burn the higher oxygenated fuel. As a market, ethanol is constricted in its growth because it is only “plug-compatible” with 10 percent of the install base. Biodiesel is 100 percent plug-compatible with the install base. You don’t need to change anything in the engine. So the real market for biodiesel is the entire diesel market, which is 62 billion gallons. There were only 75 million gallons of the stuff in 2005, which is a 0.005 percent share, and we made 150 million gallons in 2006. When my refinery comes online in 2007 with another 100 million gallons, we should be above 25 percent of the U.S. production of biodiesel.

Demand is already well ahead of supply. Biodiesel has been selling for roughly $62 a barrel. From January of 2006 until September we were selling biodiesel cheaper than petroleum- sometimes by up to 50 cents per gallon. When crude was at $72 a barrel, we were selling for $62 a barrel, which is 50 cents a gallon cheaper. Consider also that this is domestically sourced from a terror-free area that is cheaper than the competition.

The reason why I am building a large refinery is that customers-the large fleets-need a large consistent source of supply. Up until now, the industry has been so small that this hasn’t been possible.

For example, one customer who signed a contract with us to buy 25 million gallons a year for the next four years was able to reduce his company’s risk exposure. This large industrial user burns 125 million gallons a year of diesel, which represents roughly a $450 million expense line on their P&L. The CFO determined that this expense line correlates 100 percent to crude oil prices, which are incredibly volatile. He reckoned that if he could get a meaningful percentage of that expense-say 20 percent correlated to a different commodity, such as agricultural soybeans-it would reduce risk exposure in that line. That’s the simple math that a smart CFO will do.

What timeframe have you given your investors for their returns?

We have a 10-year life to our fund, and we typically look at five- to seven year life cycle returns. I can’t speak for all of my investors, but most are in for longer terms than, for example, hedge fund investors who have a trader-type mentality. They are all private investors who are used to investing in private companies that offer you no liquidity. We will need more money. We have options to build three more refineries, which would cost another $150 million to $170 million plus working capital. This company will need $500 million in the next three to five years.

Keep in mind that overall this is about a third of the capital that you would spend if you were using traditional methods to make diesel. That’s why we can be profitable. For example, a standard refinery is expensive with a high fixed cost. You only make money with high utilization. The U.S. hasn’t seen a new refinery in 23 years. It can be as much as $2 billion to build and usually needs to run at 65 to 70 percent utilization before all of its fixed costs are covered. Our refineries cost $50 million; our breakeven is about 20 percent utilization.

Talking Trash

Garbage in, profits out might sound like a dubious business model. But it’s working for Tom Szaky, who dropped out of Princeton to sell worm poop.

The original idea for Terra- Cycle came to Tom Szaky when, as a 19-year-old Princeton student, he and his roommates went to Montreal to indulge in a bit of underage drinking. A friend there was growing plants in his basement and hadn’t had much success with chemical fertilizers, but did amazingly well when worm food was used. As Szaky recalls, “The light bulb went on for me. The plants were thriving because the garbage fed to the worms generated worm poop that served as this fantastic fertilizer.”

Upon returning to Princeton, the behavioral economics major wrote a business plan using a business model “where you get paid at both ends”- to take the waste away and again for the end product. During the summer of his freshman year, he took all his savings, maxed out his credit cards and invested $20,000 into scaling a system of converting garbage into “lots of worm poop.”

While his fellow students were interning at Goldman Sachs, Szaky shoveled rotting food waste and slept on the floor of a friend’s dorm room. Just as the venture seemed poised to end in frustration, a local radio program picked up the story. “Someone heard the show and called to say he wanted to give us $2,000-not a lot of money but it saved the company,” he says.

Since their worm poop company lacked the charm of a dot-com start-up,Szaky and his pals entered business plan contests, collecting amounts ranging from $5,000 to $20,000 to keep their idea alive. The piecemeal financing method saw them through their sophomore year, during which Szaky dropped out of Princeton to pursue the venture full time. (His parents did not learn this at the time-and were not amused when they did.) During this time, he figured out how to liquefy the worm poop-a big turning point in the enterprise’s fortune. A business plan contest that earned them a $1 million prize in May of 2003 might have been another big step, but the founders had to turn away the funding because of the terms. “They wanted us to change our management,” the spiky-haired Canadian now remembers, “but even worse, they also wanted us to move away from garbage, which was the essence of our company.”

Just as bank funds were dwindling to slightly over $500, a badly needed breakthrough came when the company hit upon the idea of using discarded 20-ounce soda bottles for its “tea,” as the brew became known. With this epiphany, the idea of a product not only made from waste, but packaged in waste, crystallized. Meanwhile, media coverage of the $1 million contest won the interest of angel investors and funding of more than $1 million in just six months. Another $4.5 million soon followed, along with the promise of another $2 million on the way.

The reaction from Big Soda was mixed. Coca-Cola’s initial reaction was cool to the fledgling Trenton, N.J.-based outfit but the company has since come on board. PepsiCo, on the other hand, embraced TerraCycle more readily.

“Within 10 days of Pepsi first hearing about us, we had a meeting with every one of their vice presidents in the marketing division talking about ways we can further this,” says Szaky.

Like many entrepreneurs, Szaky, now 24, is evangelical about his product; but unlike many green entrepreneurs he doesn’t position it as a vehicle to save the world from itself. Whole Foods sells TerraCycle fertilizers, but Szaky shrewdly sought relationships with big box retailers, which are now his biggest customers. Consumers, he contends, may support politically correct products, but their purchase behavior demonstrates that they are value-conscious. It’s nice if a product is eco-friendly, but it’s nicer if it works better than the alternative and doesn’t cost more.

Recently, CE caught up with the sultan of worm poop in his graffiti-festooned factory in Trenton.

Instead of starting with small independent retailers you managed to sell to Wal-Mart and Home Depot Canada. How does a small, unknown outfit with no track record approach a giant big box retailer?

Tremendous persistence. We called Wal-Mart every day, five times a day for 60 days before the buyer took our call. He said he would give us a meeting if we promised to stop calling. Just a few weeks ago, we were in Phoenix meeting with PetSmart. They’re excited about potentially launching our product, but it took 40 phone calls from one of our salespeople to get the meeting.

If anyone wants to know the trick to getting into major retail, it’s persistence. That’s pretty much it. We have a rule here in sales: You should never assume anyone’s ever going to call you back or return any email of any sort.

Didn’t they ask about product effectiveness?

Oh, we had already proven that our product was 30 percent better than chemical fertilizers. TerraCycle was independently rated by the Zerofootprint Foundation, Eco-Options Foundation and others as the most eco-friendly consumer good. But unlike most eco-friendly items, ours is not more expensive because of the way it’s made. For example, if we used recycled plastic, it would drive up the cost. Most organic, eco-friendly items are more expensive because they’re luxury goods-which means that only 5 percent of the population choose to buy them. In surveys where people are asked if they would pay more for an eco-friendly product, only 5 percent say they will, but 100 percent say they will buy the eco-friendly choice if price is not an issue. We are the only company in North America that reuses soda bottles in packaging. Wal-Mart recently created an environmental report card that they are giving to vendors this year. Re-using packaging is on the list because no one does it. That’s what helped persuade Wal-Mart to launch us. We had no production, no track record and they gave us a quarter-million-dollar order plus end-caps nationally.

At TerraCycle’s trenton plant, five different varieties of “tea ” are brewed

So you’re a hard-headed business person, not an eco-romantic?

I’m not an environmentalist at all. I don’t buy organic food. I don’t drive a hybrid. I’m here to show that I can make a tremendous amount of money for my investors. The consumer wins by not having to pay more. The retailer wins by getting great margins. My shareholders win because we grow the company at 400 percent a year consistently and we’re doing that in the most eco-friendly way possible.

How do you market your product, other than word of mouth?

We use national guerrilla marketing tactics. For example, we set up a program where a school, a church or animal shelter can have boxes delivered to them for the purpose of sending used soda bottles to us. We pay five cents a bottle and the sender knows it will be recycled. What’s more, they fill out names on neck tags that are placed around our final product so a TerraCycle purchaser sees that the original bottle was saved from the landfill by “Jill from California” or “Billy from Massachusetts.” It personalizes the recycling effort. We have 1,700 locations that do this. The number of groups signing up on our Web site grows by 30 to 50 a week, and we’re not even promoting it.

We have two full-time publicists who call each of these locations and say, how much money did you raise? Okay, $30. What are you doing with that $30? One kindergarten class used the money we sent them for its pet rabbit that needed surgery-true story. That’s a great local human interest story that was featured on the cover of the local paper. We average at least two publicity hits on the bottle brigade stories across the country every week. Local papers have no staffs. They’re becoming syndications for AP and Reuters, which means they crave local stories. Our engine pushes local stories. These are the kind of stories our partners like Wal-Mart, Home Depot and Target can’t readily get. When we met with the Wal-Mart PR team, they told us that all they care about is getting positive local press. We said, “Hallelujah, we do that well.” That’s something that our halo produces, and Miracle-Gro can’t.

In addition, we spend a lot of our money on in-store material displays. Miracle-Gro advertises the idea of gardening. We can’t afford that, so we try to educate people about the brand and then get them to select our product once they’re in the store.

What do you suppose the folks at Scotts make of TerraCycle given that your sales are not significant enough to worry them?

Oh, I don’t necessarily agree with that. There are four major players, with Scotts being the biggest. We’ve already had acquisition interest from two of them. It’s too early, and we’re not really interested in that now, but it’s good to see. We’re definitely getting aggressive pushback from Scotts because we’re taking shelf space away. In Home Depot, we’re going to have three feet of shelf space this year. Competitors might have anywhere from 50 to 100 feet, but every increment helps against Miracle-Gro, the dominant player.

Are you concerned that the big boys might come up with an eco-friendly product to rival yours?

They couldn’t come up with something this eco-friendly. Miracle- Gro, which invests most of its R&D into genetically modified turf grass, is at the exact opposite end of the spectrum. They have launched organic products, but organic is just one aspect of their product line. Keep in mind that ours is the more effective product. The word “organic” doesn’t appear on the front of our label. We don’t even talk about it because that’s not the reason you should buy this product.

We’re moving so fast that we’re pumping out new products with great concepts in an environment where there’s very little innovation: deer repellent, de-icers, fire logs-anything in the lawn and garden space as long as we can reinvent it in an ecofriendly fashion-not just slightly more eco-friendly, but the most ecofriendly choice.

Where do you go from here? What are your future plans?

We’re executing strongly on our 2007 plan. We’re aiming to be a $5 million to $6 million company, which we’re pretty much on track for. We hope to launch probably 20 new products in 2008, add more retail and then keep aggressively expanding our product offerings. We want to become the Procter & Gamble of eco-friendly products. That’s our goal.